OGX Default Seen in Bond Plummet as Batista Empire Sinks

More than $28 billion of OGX Petroleo & Gas Participacoes SA Chairman Eike Batista's personal wealth has evaporated since last year as shares plunged 94 percent since March 2012 and his oil producer struggles to meet output goals. Photographer: Patrick Fallon/Bloomberg

June 14 (Bloomberg) -- OGX Petroleo & Gas Participacoes
SA’s bonds are falling like never before, a sign that investors
are bracing for what would be the biggest company default in
Latin America as controlling shareholder Eike Batista struggles
to raise cash.

The oil producer’s $2.56 billion of notes due 2018 have
plummeted 16.9 cents this week, the most since the debt was
issued in May 2011, to a record-low 40 cents on the dollar. The
securities are trading below the average of 45 cents for
defaulted Latin American corporate debt tracked by Bloomberg and
less than the maximum 50 cents on the dollar that Fitch Ratings
estimates bondholders would recover in a restructuring. Fitch
cut OGX’s credit grade one step to CCC today, or seven levels
below investment grade. It has a negative outlook on the rating.

While OGX said it isn’t analyzing a debt restructuring,
investors are losing confidence Batista can honor his
obligations as an 83 percent plunge in personal wealth pushed
him to sell OGX shares and other stakes in his faltering
commodity and energy empire, SW Asset Management and Brookshire
Advisory & Research said. The company is set to run out of money
in about a year at its burn rate as slumping production puts
output goals out of reach, even after Batista pumped at least 2
billion reais ($943 million) of his own cash into OGX.

The market “is pricing in some type of restructuring,”
Ray Zucaro, a money manager who helps oversee $325 million of
emerging-market debt at SW Asset Management, said in a telephone
interview from Newport Beach, California. “There are a lot of
rumors. Where there’s smoke, there’s fire.”

‘Deliver More’

OGX is not analyzing a debt restructuring, a company press
official said in an e-mailed response to questions. Cash
generation from current and future production, potential sales
of stakes in oil fields and an option that would oblige Batista
to purchase as much as $1 billion of OGX shares will all allow
the company to continue servicing its obligations, the official
said.

Batista said in a statement yesterday that OGX parent
company EBX Group Co. restructured debt and now only has long-dated maturities. The restructuring “is clear evidence of EBX’s
high level of commitment toward its obligations with
stakeholders,” he said without providing further details.

Share Sale

Pacific Investment Management Co., the world’s largest
active bond-fund manager, was the biggest holder of OGX’s notes
as of March 31. The Pimco Income Fund, which has outperformed 99
percent of peers over the past three years, held $128 million in
principal of OGX bonds as of the first quarter, according to
filing data compiled by Bloomberg.

OGX’s 2018 bonds plunged 8.7 cents June 11, a day after
Batista said in a filing that he sold 70.5 million shares
between May 24 and May 29 for 122 million reais at an average
price that’s more than 90 percent below its all-time high.

Fitch citied “increased uncertainty” about Batista’s
ability to honor the $1 billion put option available to OGX in
its decision to downgrade the company. Bonds rated CCC carry
“substantial credit risk,” with default “a real
possibility,” according to the rating company.

Last month’s sales of OGX voting shares represent a
“minimal one-off adjustment” in EBX’s portfolio and were part
of efforts to extend maturities and reduce debt costs, Batista
said in the statement, adding that he has no intention of
selling more shares.

OGX Cash

More than $28 billion of Batista’s personal wealth has
evaporated since last year as shares plunged 94 percent since
March 2012 and his oil producer struggles to meet output goals.

OGX’s cash holdings fell 68 percent in the 12 months ended
March 31 to $1.14 billion, enough to keep it operational into
the fourth quarter at the company’s current burn rate, according
to data compiled by Bloomberg. While OGX raised as much as $850
million selling an oilfield stake to Malaysia’s Petroliam
Nasional Bhd. last month, the amount would only extend cash
reserves until mid-2014, the data show.

“It appears restructuring activity is imminent,” Gianna
Bern, a former senior director at Fitch Ratings who is now
president of risk-management adviser Brookshire Advisory and
Research. “Offshore drilling is a very capital intensive
business. Bringing the product online has taken much more than
investors would have ever hoped for.”

Oil Output

Batista lured investors to his oil startup with promises of
output of as much as 730,000 barrels a day by 2015 and 1.4
million barrels a day in 2019. Crude production climbed to 6,800
barrels a day in May after slumping to 1,800 a day in April as
the company shut two of three wells at its only active offshore
field, known as Tubarao Azul.

OGX has $109 million of interest due in December on its
2018 bonds and $44.5 million in interest due in October tied to
its $1.06 billion of 2022 notes, according to data compiled by
Bloomberg.

Fitch estimates investors would recover 31 percent to 50
percent of current principal and related interest in the event
of default. In May, the rating company cut OGX’s credit grade to
B-, or six steps below investment quality, and revised the
company’s outlook to negative after it acquired 13 exploratory
blocks in Brazil’s first round of oil bidding in five years.

‘Liquidity Risk’

“The liquidity of the company was already at risk,” Ana
Paula Ares, an analyst at Fitch, said by phone from Buenos Aires
yesterday. “It has a significant capital expenditure program
and has faced delays for production to come online. The fact
that in this scenario, instead of preserving cash, the company
went out and acquired assets, that increased the liquidity
risk.”

Michael Roche, an emerging-market fixed-income strategist
at The Seaport Group LLC, said OGX’s bonds have the potential to
rebound as oil output increases.

“The bond market is in alignment with book value right
now,” Roche said by telephone from New York. “That’s why I
expect some stability. If they’re drawing 40,000 barrels a day,
the bonds would increase. That’s the great optionality.”

The extra yield investors demand to own Brazilian
government dollar bonds instead of U.S. Treasuries was little
changed at 217 basis points at 2:45 p.m. in New York, according
to JPMorgan Chase & Co.’s EMBI Global index.

Default Swaps

The cost of protecting Brazilian bonds against default for
five years dropped five basis points to 149 basis points,
according to prices compiled by Bloomberg. Credit-default swaps
pay the buyer face value in exchange for the underlying
securities or the cash equivalent if a borrower fails to adhere
to its debt agreements.

The real weakened 1.1 percent to 2.1446 per dollar. Yields
on interest-rate futures contracts due in January rose two basis
points to 8.74 percent.

A dollar debt restructuring by OGX would be nearly double
Banco de Galicia y Buenos Aires SA’s $1.9 billion default in
2002, the largest in Latin America to date, according to data
compiled by Moody’s Investors Service.

“It all depends on what’s going to happen in the fourth
quarter with” oil production, SW Asset Management’s Zucaro
said. “It’s very binary at this point. If that produces oil,
the company probably will not need to. If it doesn’t, the
current capital structure is unsustainable.”